When Will Asset Prices Crash? - Part 11

The subterranean process, by which the demand for labour gradually rises, as the long wave cycle moves into its boom and crisis phases has been described. But, the artificial contraction of supply caused by lock downs, followed by the unleashing of vast amounts of monetary demand into the economy has amplified that process by many times. A channel can cope with a given flow of water if it passes through it over an extended period, but if it hits it all at once, the channel cannot cope, the water overflows, the banks of the channel are burst. Its not that the global economy cannot cope with the surge in demand that is occurring, as the global economy is forecast to grow at the fastest pace in fifty years, it is that it cannot cope with that surge coming in such short order, at a time when supply chains have been broken, and are being restrained, when free movement of labour is constrained, and when it is necessary to again bring available resources into operation.

The inevitable consequence is that, with large amounts of liquidity sloshing around the global economy, it floods into those areas where shortage of supply and high levels of monetary demand has pushed up prices. Over time, as demand for goods and services rises, companies find ways of increasing supply by efficient means, but hit by a sudden increase in demand, and ability to simply raise prices, firms use whatever means is quickest to satisfy market demand, and capture market share. China has told its energy producers to ramp up production including the use of coal, and the price of Indonesian lignite has risen sharply. Its also why the prices of other fuels such as LNG have increased sharply. As one commodities analyst told Bloomberg: “They will bid whatever it takes to win a bidding war”.

Over a period, firms buy additional machines, capacity, or new types of technology to deal with such increased demand, but faced with sharply higher demand, here and now, with the ability to simply charge higher prices, firms are responding by just hiring additional workers, where they can get them. The consequence is that the process of the rising demand for labour, the growing wage share in the economy that was already occurring, though at a slow pace, has had boosters put under it. In the late 50's and early 60's, that process meant that unemployment fell to around 1-2%. Calculated on the same basis as then, unemployment in Britain today, is around 7-8%. In the early 60's, it was the basis upon which workers were able to assert their interests, and to rebuild the labour movements that had been shattered in the 1920's and 30's. The start of that was beginning to be seen by 2007/8, as wages, again, began to rise, and workers in Germany and Britain and elsewhere again found that even a short strike could win large pay rises, as firms competed for labour. Moneyweek reports,

  

“This is already happening. In Germany, the FT reports, “increasing numbers of German workers are demanding higher pay amid rising inflation, with some going on strike”. For example, the country’s biggest union, IG Metall, is demanding a 4.5% pay rise, plus added pension benefits, for workers at one group of companies in southern Germany.

It’s a similar story in Australia. Capital Economics notes that “union officials’ inflation expectations have surged… A push by union officials to offset rising living costs coupled with severe labour shortages provide fertile ground for wage hikes in upcoming enterprise bargaining agreements.”

In Britain, we have already seen that, when it comes to hiring labour, firms, particularly in specific sectors, have been having to offer wages between 18-30% higher. When existing workers see that happening, in the context of labour shortages, they will begin to demand similar increases, and will be able to move to these higher paying jobs if employers do not cough up. Already, in the US, one reason for levels of new unemployment claims not falling as rapidly as expected is that workers “quit rate” has increased. That is they are now quitting their existing jobs, and moving to higher paying jobs. The unemployment claims simply reflect this frictional unemployment between jobs.

So, many of the conditions required for interest rates rising, are already in place, and what is also in place is rapidly rising levels of inflation that is clearly not going to be transitory in the way that central banks have been claiming. The US Federal Reserve is already having to hedge its language in that regard as its persisted, and increased, beyond the few months it was suggesting initially. It is likely to begin tapering its QE next month, and its predicting raising its policy rates next year. I suspect that is going to come sooner than its “dot-plots” currently suggest. Bond prices are already falling, and yields rising sharply, though they have not yet got to the levels seen earlier in the year, before further lock downs were introduced, at a time when it was thought that economies were opening fully. Nevertheless, the pace of the rise has been sharp, even as warnings about the Delta Variant are being used to justify the threat of yet more restrictions.

Some time ago, I pointed out that the cause of rising interest rates was not inflation, but increased economic activity that results in the demand for money-capital rising faster than its supply. Marx illustrates that you cannot reduce interest rates by simply printing more money tokens. The increased supply of tokens merely reduces their value, causing inflation. The prices of the commodities to be bought with the borrowed money, thereby, increases, so that the nominal demand for money-capital rises at the same time as the nominal increase in supply, leaving the fulcrum/rate of interest, balancing the demand and supply unchanged. However, there is, of course, a difference between this effect of a rise in nominal amounts on both sides of the equation, with what happens in so far as someone lending money at current prices, and getting paid back some time later, at higher inflated prices. It means that the capital they lend today, becomes worth less, as a result of the inflation, when it is paid back at some time in the future.

If I lend you £1,000 today, and inflation is 10% p.a., then, when you pay me back a year from today, the £1,000 you pay me will, in effect, be worth only £900. So, I will want to ensure that the rate of interest I charge you covers me for what I expect that rate of inflation to be during the year. As inflation rises, and appears to become more than something transitory, lasting just a few months, then anyone lending money is going to feel increasingly worried that the guaranteed capital gains they expected from speculating in the purchase of such assets might disappear and turn into losses, certainly real, after inflation losses. So, currently, we have two effects pressing down on asset prices – increased economic activity, resulting in increased wage share, and squeezed profits, causing interest rates to rise, and rising levels of inflation that look more than just transitory.

Again, when we look at the real world, and all those subterranean processes, they can also have other consequences. If we take the big pension funds and mutual funds, they have billions of Dollars that they must invest. Most of them, other than hedge funds, have to be long the market in some asset or other. Hedge Funds are unusual in being able to bet on the price of assets falling. Pension Funds, in particular, because they have commitments to provide revenue streams into the future are legally bound to keep a proportion of their investment in long-term assets, such as government bonds. So, when asset prices are falling, many of these institutions are left in the position of only being able to shift the balance of their holding from one asset class to another. They could not even decide to put all of their funds into cash, and only specific funds can put money into, say, gold. Some have been wanting to be able to buy klepto-currencies, but given that they have no value, and are likely to be the worst affected assets when the crash comes, its a good thing that currently they can't. Its perhaps one reason that China has clamped down on speculation in the klepto-currencies.

Of course, the savers and speculators who put their money into these funds, can take their money out, and put it, themselves, into cash or gold, but as was seen when property prices were crashing sharply, unless you have done that before the crash starts, its too late. You can't get out of them straight away, and if they face large scale redemptions, they close the fund, preventing people getting their money out. People who have had money in bond funds, will have found, over recent years, that despite negligible yields, the funds will have risen, on the back of capital gains. I suspect that, as savers with money in such funds start getting their statements in coming months, they are going to see significant losses, as bond prices have fallen sharply. There is nothing like seeing that the money you thought you had in a “safe” bond fund, has overnight lost 20% of its value, for making you think about whether it would be better off under your mattress.

But, one of the other major assets held by large numbers of people is property. If you own it because its the place where you live, its different than if you own it as an asset, from which you obtain rent, or expect to obtain a capital gain from rising prices. For the latter, its no different than owning bonds or shares, or some other asset. You can sell it if you think that, instead of capital gains, you are going to suffer capital losses. The difference is that you can sell bonds and shares at the press of a button, as more or less liquid assets, but it can take months to sell a property, and the more you have the longer your money is tied up. But, people buy and sell houses to live in for entirely different reasons. Moreover, those reasons may lead them to act in ways that changes in asset prices would not normally be expected to produce.

After the war, my parents were like millions of other newly married couples. They had my sister as a baby, and there was a general shortage of accommodation. Like many others, while my father was still in the army, they shared with other family members, but that became increasingly difficult. My mother and sister lived, for a time, in lodgings in an old terraced house, from which they were desperate to escape, in part due to the nature of the old woman who owned it. When my dad came out of the army, they decided to buy a house, and that meant buying whatever they could get within their means. Looked at rationally, and with the benefit of hindsight, it was a very bad decision, because, with such a mismatch of demand against supply, prices were sky high, pretty much like today. In addition, as new council house building, and building by private housebuilders got underway, the supply of available houses was going to increase, meaning that prices would moderate.

In fact, they more than moderated. My parents paid £1,000 for an old terraced house in 1947. When the Council came to demolish it, in 1974, they were offered just £1,000 for it, a £1,000 that, by then, was worth, perhaps, just £100 in 1947. In fact, within two years of my parents buying the house, they could have bought a brand new, semi-detached house, in the village, for just £250! But, economic theory and hindsight is one thing, practical activity, under pressure of trying to do the right thing in the conditions you find yourself in is another. There are no doubt many people, today, who find themselves in similar situations, with house prices at even more astronomically inflated levels compared to their historic averages. The sensible thing is to try to avoid suffering such a capital loss, but given the need to live somewhere, the choice is not always that simple.

I think that we are on the verge of an historic crash in asset prices, for the reasons I have described. As with the next great San Francisco earthquake, its been long predicted, and indeed, seen as overdue, but no one can say exactly when it will happen, but we do know it will happen, and why. The same with the coming asset price crash. No one can say exactly when it will happen, but we do know it will happen, and we know why it will happen, for all of the reasons set out in these posts. What I can say is that, looking at the conditions that exist today, of a sharp rise in economic activity, with UNCTAD predicting the biggest increase in global growth for more than 50 years, with widespread labour shortages leading to rising wage share, and a consequent squeeze on profits, with inflation rising, and even threatening to become embedded, and with the pressure on interest rates, thereby, intensifying by the day, the conditions look very much like those that existed in 2007/8 that led to that financial meltdown. The difference, today, is that asset prices are even more astronomically inflated than they were then, and the levels of liquidity even greater, the policy rates of central banks even more surreal. What is more, the levels of borrowing by states are at more elevated levels, as they have financed the consequences of lock downs.

The chances of constraining economic activity seems extremely limited, as a means of preventing interest rates from rising, and yet, without doing so, economic expansion is going to continue to develop those trends at an accelerating pace, causing interest rates to rise at an increasing pace, as the supply of money-capital falls more and more compared to the demand. The only thing keeping asset prices inflated is the continued hope that they might be higher tomorrow, a hope based solely on the ability of central banks to bring that about. But, in conditions of sharply rising economic activity, even greater levels of QE will simply feed directly into rising levels of inflation, destabilising the system, and causing speculators to run for the hills.

Back To Part 10